Managing Personal Finances, Taxes and Savings as a Freelancer
The flexibility and freedom offered by a freelance career have significant appeal. As the pandemic has shifted ideas and perceptions around work, more people have taken on a part-time side hustle or full-time freelancing gig to better suit their lifestyles. A recent study commissioned by Upwork found that in 2020, 59 million Americans performed freelance work in the past 12 months, representing 36% of the U.S. workforce. In other words, more than 1 in 3 people now have some kind of freelance job.
Being self-employed means there are aspects of work traditionally handled by an employer that an individual must take care of — such as invoicing, paying taxes and obtaining insurance. Staying on top of your personal finances can set your business up for success.
The Freelance Life: Benefits and Drawbacks
Anyone who works for themselves, rather than for a company, is considered a freelancer — from independent contractors to gig workers. There are many benefits to freelancing which makes it an attractive way of working.
But there are also a number of drawbacks, along with unexpected issues that arise with a variable income. Some people may choose to freelance part-time and retain a so-called day job, while others may go all-in, designing their life and career as they go. Considering the pros and cons of being a freelancer can help guide your decisions as you move forward.
Benefits and Drawbacks
- Freedom to choose clients and projects. The ability to decide who you want to work with and how many clients you have — in addition to your workload — is an appealing prospect.
- Independence. Being free of a traditional 9-to-5 job means greater flexibility with your schedule, as well as the opportunity to work where you want to and when.
- Greater opportunity to set your rates. For many freelancers, the chance to earn greater exposure and income beyond the confines of one salaried job outweighs the challenges freelancing brings.
- Lack of benefits. Since freelancers are self-employed, they need to pay for benefits which would otherwise be provided by a salaried employee, like health insurance.
- Taxes. Staying on top of taxes as a freelancer can be tricky when amounts aren’t automatically deducted from a weekly salary.
- Cash flow issues. Varying terms of payment from client to client — or a complete lack of timely payment — can make managing finances as a freelancer extremely frustrating.
How to Budget Your Money
Sticking to a budget is vital if you have an unpredictable income or payment schedule. Good habits can help. The tips and strategies shared here can show freelancers how to build a solid financial routine even with variable income.
1. Determine Your Rate
Every freelancer — from writers to graphic designers to engineers — needs to know how to price their work. Some may choose to charge an hourly rate, while others prefer project-based fees. Deciding what to charge as a non-salaried employee is one of the first steps to ensuring you embark on a viable freelance path.
Calculate your expenses
To start, work out all monthly costs you have as a freelancer. These should include professional expenses, such as your office space, materials, internet bills and equipment, in addition to regular expenses such as your rent, food and clothes. Keep in mind that becoming debt-free should always be a priority, particularly if you take a non-traditional job.
Make a work schedule
Take into account sick days and vacation days to establish how much you need to work to reach your income goals. Be sure to leave a few days in your schedule for adminissues, like sending emails and filing taxes and invoices.
Establish a baseline
A baseline is the minimum rate you are willing to work for. It’s generally advised to price up from your baseline to account for any issues that may come up along the way. You can also raise your baseline as your experience increases and your skills develop. As a precaution, always keep enough money on-hand to compensate for dry patches where you may be waiting for payment.
2. Decide if You Are Sole Proprietorship or Limited Liability Company
Sole proprietorships and LLCs are two of the most common business structures. Knowing how to choose which structure is best for you is one of the most important decisions you’ll make.
Many freelancers opt for sole proprietorship, where you can begin working from the get-go under your own name rather than a business name.
Pros and Cons of a Sole Proprietorship
- Simple. A sole proprietorship is considered one of the easiest types of businesses to start. Unlike an LLC or a corporation, you generally don't have to file any special forms to start working.
- Cost-effective. A sole proprietorship is free to start. While you may have to pay for permits depending on your line of work, you won’t pay the average $1,000 cost involved with starting an LLC.
- Simplified tax filing. As a sole proprietor, you’ll pay income tax on all your business nets, and profits/losses will pass through to your personal tax return. These are typically reported on a Schedule C tax form filed with a personal tax return.
- Personal assets at risk. As a sole proprietor, there is no separation between you and your business. While you’re entitled to all profits, you also carry all debts and obligations and can even be held responsible for liabilities caused by any employees.
- Difficulties obtaining financing. Many investors choose not to invest in a sole proprietorship, as they’re sometimes seen as lacking in professionalism. This could potentially limit the amount of funds available to grow your business.
- Difficulties obtaining a credit line. Some financial institutions may see a request for credit as a personal loan rather than a business loan, which can limit the amount of credit you’re approved for.
Limited Liability Company
Some freelancers may also opt for the formal business structure of a limited liability company, or LLC. With an LLC, you’re not personally liable for debts, whereas a sole proprietor would be liable for debts incurred by a business. Weighing the pros and cons of each can help you decide which is best.
Pros and Cons of a Limited Liability Company
- Liability protection. If you set up and maintain your LLC properly and avoid mixing personal and commercial assets, you’ll gain liability protection of your personal assets against commercial debts, lawsuits and other obligations.
- Ease obtaining equity and debt financing. A separate business entity will help you qualify for small business loans instead of personal ones, opening you up to greater opportunities for leases, trade credit and more.
- Tax benefits. Both LLCs and sole proprietorships offer advantages in federal tax laws that allow for a pass-through deduction of up to 20% of a business income. The process for filing taxes for an LLC is relatively simple, although details may vary from state to state.
- Higher costs during filing season. The costs for completing the tax return of an LLC may be higher than that of a sole proprietorship. The Small Business Administration and IRS can provide additional information.
- Additional expenses. Besides paying federal, state, local and the self-employed version of FICA taxes, you might also be required to pay State Business Taxes and Unemployment Taxes.
- Attention to detail. In an LLC, you must be careful to keep banking records and funds separate from your own personal records and funds. Violating this rule can result in the loss of your limited liability protection.
3. Calculate Your Expenses, Taxes, Insurance and Savings
Performing a simple 30-second audit on a monthly basis can help you stay organized. An audit should include a calculation of your expenses, including rent/mortgage and equipment, as well as your taxes and savings. You can manage or organize your expenses by doing the following:
Create and follow a budget
Since your income as a freelancer may vary each month, it helps to calculate the average of what you bring in. Use that to track your earnings and expenditures every month and create a budget.
Calculate your fixed and variable expenses
Rent and utilities are fixed, while variable expenses like groceries and travel fluctuate. With that in mind, establish a fixed salary that allows you to cover costs.
Work out your quarterly estimated taxes
It can be easy to forget about taxes when you’re starting out. Be sure to calculate what you’ll owe based on your bracket and the state you live in so there are no surprises during tax season.
Know how much you need for savings
Savings include an emergency fund as well as any retirement funds or investments. In case of any unexpected events or cash flow issues, you should work towards having at least six months of money on hand.
Don’t forget insurance
What to Do if You Find Yourself in Debt
Some freelancers may end up relying on credit cards or loans to get through lean times. This can lead to mounting debt which can quickly become overwhelming. Interest also accrues over time, making small debts costly in the long run.
Aim to consolidate all your debt and pay it off in a manageable monthly amount as quickly as possible. Be sure to check that the interest rate you’re paying is the lowest it can be, and if possible, see if you qualify for a zero-balance transfer card that can help knock down debt faster.
It’s never too late to improve financial literacy skills or consult an expert for additional help.
Understanding Your Taxes
Paperwork and jargon can be unnerving to even the most confident of freelancers. But doing taxes as a freelancer does not need to be headache-inducing. According to the IRS, every self-employed person who earns $400 or more must file an income tax return, which means reporting all sources of income for the tax year.
In addition to your regular income tax based on your tax bracket and filing status, freelancers need to pay self-employment tax, which is currently about 15.3%. Self-employment tax covers the Social Security and Medicare taxes that would ordinarily be taken out of a paycheck from a salaried job.
Type of Forms
In a salaried job, documents needed to organize and pay one’s taxes usually entail a single W-2 form. As independent contractors, freelancers need to fill out W-9 forms for each company they work with. Generally, companies will send out a 1099 at the end of the financial year showing all the income earned by a freelancer. Having the right paperwork can make filing your taxes significantly easier. Here are six documents you’ll need to be aware of:
- Form 1099-MISC: A business which pays a contractor $600 or more during a calendar year must report payments to the IRS using a 1099 form. You’ll get a 1099 from each company you work for during the year, so hold onto them. You won’t need to send them to the IRS but should keep them for your records and use them to tally your income at the end of the financial year.
- Form W-9: Businesses use the name, address, and Social Security number or tax identification number that freelancers provide on Form W-9 to complete their 1099s. W-9s are not sent to the IRS.
- Form 1040-ES: This form is used to estimate and pay your quarterly estimated taxes. It helps you keep pace with your income taxes, reduce the total amount you owe come tax-time and avoid penalties for underpaying. This document is prepared by you and not by the business you work with.
- Schedule C: The Schedule C is the form you’ll use to report income or loss from a business you operated or a profession you practiced as a sole proprietor.
- Form 1065: If your enterprise is a partnership, you need to also file Form 1065 to inform the IRS about your partnership’s annual earnings, deductions, profits, losses and tax credits.
- Financial Statements: Financial statements are your own forms of documentation about expenses that you can deduct from your taxes. Be sure to keep a log of any mileage you do for work and save receipts for any other business expenses.
Paying Estimated Taxes
Freelancers who expect to owe $1,000 or more in taxes are required to pay estimated taxes quarterly because freelance income is not withheld by employers throughout the year. The IRS Form 1040-ES can help you estimate how much you’ll owe in taxes every three months.
Remember, it’s important to get these payments as close to the real number as possible. If you underpay your quarterly taxes, you will owe the IRS the remaining balance when you file your annual tax return by April 15. You may also have to pay an additional fine.
How Deductions Work
As a freelancer, you can subtract some business expenses from what you owe, so it’s worth studying all the deductions permitted by the IRS and keeping track of your work-related expenses. The deduction list includes items purchased to conduct business, such as books, magazines, reference material, purchases of equipment (like a laptop and office supplies) and business insurance.
Other categories include travel and entertainment, such as airplane tickets, trains, Uber rides, subways and buses, along with business meals. If you are a part of any professional organization, membership fees qualify, too, along with the costs of day-to-day business operations, such as office rent and utilities.
When You Should Involve an Accountant
You may choose to do your own taxes through sites like HR Block or TurboTax. But for freelancers who feel they may not catch all their deductions or have returns that are excessively complicated and may involve penalties, it’s always a good idea to seek the help of a professional tax consultant or an accountant.
A professional can also make sure you’re putting in place habits that last all year, so you don’t scramble for information come tax-time.
Finding Insurance Options
Taking care of your insurance needs should be a key consideration if you are a freelancer. Since you’re not relying on benefits from a traditional salaried job, protecting yourself, your business and your assets is of utmost importance.
Finding the right insurance, whether you’re operating as a sole proprietorship or an LLC, will ultimately give you a greater sense of security in your career and life.
Having health insurance is one of the reasons many people put off becoming a freelancer. Understanding what options are available can help you make an informed decision and lessen the risk of an unexpected medical emergency.
The average cost of health insurance for freelancers depends on several factors, such as where you live, your income level and the size of your deductible. Many freelancers buy health insurance through the Affordable Care Act (ACA or Obamacare) marketplace on HealthCare.gov.
All plans listed on the site meet basic government-mandated requirements. Organizations like the Freelancers Union also offer affordable health insurance plans, and you can find out if you qualify for Medicaid, the government-sponsored health insurance for low-income people.
Always take care to avoid health insurance scams by identifying reputable insurance companies and agents.
Life insurance is another perk that tends to be included in benefits packages offered by companies. As a freelancer, it’s important to budget for such an expense, since it can help safeguard your future and protect your family should anything ever happen.
There are two types of life insurance: temporary, which offers protection for a set period of time, and permanent, which is lifelong. As with health insurance, it pays to shop around and compare quotes, and then consider your options based on your needs and budget.
You can buy life insurance from an affiliated agent, an online broker, directly from an insurance company or through a financial adviser. Organizations like the Freelancers Union also offer affordable plans. Wherever you choose to look for coverage, safeguard your identity and always thoroughly check the credentials of the policy you’re offered.
Business insurance can protect you from financial, legal or other claims in the case of an accident, lawsuit or other unexpected occurrences. The kind of business insurance you decide on will likely depend on the nature of your freelance work.
General liability insurance can protect against common accidents in the workplace, such as property damage or injuries involving a third party, which can be beneficial even to people who work from home. This policy also protects against personal injuries, including libel, slander and trademark and copyright infringement.
You may want to also consider Professional Liability Insurance which offers additional coverage for lawsuits and claims related to professional services that may arise during the course of your work.
How to Save for Retirement
Saving for retirement is one of the biggest challenges facing freelancers. When you have a salaried job, employers typically take care of the process automatically. Paying attention to your retirement savings as a freelancer can help you build a solid financial future. Here is a step-by-step guide on how to start preparing:
Build an emergency fund
Building an emergency fund is just as important as saving for retirement. Make sure you have enough money to cover three to six months of your expenses in case you have cash flow issues or an emergency comes up. This can ensure that your retirement savings are only used for their stated purpose.
Save for quarterly tax payments
Set aside a percentage of your income each month and make estimated quarterly tax payments. Doing so can help you see how much you have left to put away. Then, set automatic payments for retirement so that the money is accounted for before you spend it.
Consider your options
Since you’re not eligible for a company 401(k) as a freelancer, look into opening an individual retirement account (IRA) as either a traditional or Roth IRA. This investment account includes a collection of stocks, bonds, mutual funds and other securities and can be opened with a brokerage firm or bank.
Open a SEP IRA
If you’re a business owner or a self-employed individual, you can also open a simplified employee pension plan, which can be combined with a Roth or traditional IRA to enhance your retirement savings.
Don’t neglect your old 401k
If you previously worked for a company, make sure to cash out your old 401k. Instead of paying taxes on the amount, try to roll it over into your current plan and let it continue to grow.
Expert Insight on Managing Finances as a Freelancer
MoneyGeek spoke with industry leaders and academics to provide expert insight into the best practices that new and established freelancers can follow.
- What are the most common mistakes freelancers make when it comes to managing their finances?
- What is the biggest goal freelancers should strive for when it comes to personal finance?
Assistant Professor of Accounting at Austin Peay State University
Financial Expert, Entrepreneur, Author
Professorial Lecturer at the Department of Accounting and Taxation
Director of the Athena Center at Barnard College
Resources for Freelancers
Freelancing can be an exciting career path, but it can also be a daunting, lonely and sometimes isolating way to work. Various resources and groups provide useful information which can make it a more accessible field.
- Freelancers Union: The union is a community-driven initiative to provide resources and courses on everything from branding as a freelancer to how to pay your taxes. It also advocates for freelancers to get paid fairly and promptly. Based in New York, it has members all over the country.
- Udemy: Udemy is the place to go for classes on just about anything — from negotiation to accounting basics to running a business. Many such courses can help freelancers establish a routine.
- Contently: This site offers potential work opportunities for freelance writers and content creators but also houses useful information for creative types on its blog.
- The IRS's Gig Economy Tax Center: The IRS offers information that can help independent contractors and gig-economy workers understand how to pay their taxes. A particularly helpful breakdown on the site shows all the necessary paperwork that needs to be submitted.
- Upwork: This popular job-board connects businesses with freelancers and independent contractors around the world. Its blog also offers insights into freelancing, such as the Freelancing in America yearly study.
- CreativeMornings: This collective of creative minds has freelancers based around the world and organizes monthly talks about creativity. It also has a Creative Guild where freelancers can connect with companies to create websites or logos, and companies and agencies can find and hire them.
- Healthcare.gov's Find Help Tool: The official site of the Affordable Care Act is a one-stop shop for your health insurance needs. You can find local Marketplace-certified providers through its Find Help tool. It also offers information about how to enroll and what to look for.
- Lili: This free bank account offers mobile tax-planning tools to help freelancers and contractors manage their expenses. It also runs a blog dedicated to informing freelancers about every aspect of their careers.
About Nadia Neophytou
- Contently. "What’s the Going Rate for Freelance Writers?." Accessed August 21, 2021.
- Flexjobs. "The Pros and Cons of Freelancing." Accessed August 20, 2021.
- Freelancers Union. "Freelancing in America." Accessed August 20, 2021.
- IRS. "Self-Employed Individuals Tax Center." Accessed August 20, 2021.
- MBO Partners. "The State of Independence in America." Accessed August 20, 2021.
- Statista. "Number of freelancers in the United States from 2017 to 2028." Accessed August 20, 2021.
- Upwork. "Sixth annual “Freelancing in America” study finds that more people than ever see freelancing as a long-term career path." Accessed August 20, 2021.